NHS Trust Maternity Care Capital Budgeting: Investment Appraisal Techniques

Capital Budgeting

NHS trusts is an organization that provide the health care services to the society. The firm has long-term sustainability and has also been fined severally due to the clinical negligence claims. The firm has almost spent more than 2% of its budget to finance these claims and this makes it to be among the largest health care liability that the service providers have paid. The hospital has strategized to reduce the deaths of the babies and therefore they are improving their antenatal care and employing well trained midwives who are well supervised by competent doctors. To enhance the services the trust is planning to open an extra midwife led maternity care in their East Wing. This will involve critical thinking and the firm will have to carry out the capital budgeting decision.

The firm will evaluate the viability of project through the use of investment appraisal techniques. Capital budgeting decisions are important because they involve the commitment of large cash outflow. The hospital is planning to contribute a budget of £15 millions for the purpose of expanding to the new ventures. The firm is expecting the firm will generate income in future. it means that they are exchanging the current funds to a stream of cash flow in future. These decisions should be important to the firm because it has to evaluate the sources of the funds and the limitations available when funding the hospitals according to King’s Fund report. The purpose of this report is to advise the NHS trust on the viability of their proposals and provide them with the information on the best sources of finance to fund their proposal.

Capital budgeting

Capital budgeting decisions are evaluating the viability of purchasing the long-term assets. The capital budgeting decisions are also known as the investment decisions and they involve commitment of large amount of capital (Kumar). The trust is planning to spend a total of £15 millions to finance the extension of the new maternity section in the East Wing. The firm expects to generate a stream of cash inflow from antenatal care, birth care for pregnant women and postnatal care. Capital budgeting decisions are important because they involve future cash flow which is risky and uncertain. The investment decisions are irreversible and therefore, it is very important for the trust to evaluate the decision critically. The analyst will involve the evaluation of cash inflows and the cash outflows.

Net Present Value

The analyst will use the investment appraisal techniques that will help the firm in determining whether the project is profitable. The investment appraisal techniques are critical because they are supposed to help the decision maker to choose the investment. The appraisal techniques can be classified into discounted methods and non-discounted methods. The discounted methods are the techniques that will consider the time value in money. Examples of the discounted methods include the net present value (NPV), internal rate of return (IRR) and the profitability index (PI). These methods are preferred because they will consider all the cashflow and they also incorporate the risk and time value of money in form of the discount rate. In the case of NHS trust, the discount rate to be used in converting the future cashflow to present value cashflow is 8%.

Net present value

Net present value is a discounting capital budgeting appraisal technique that will consider the cashflow of the firm and the time value (Gaspars-Wieloch 2019). The net present value is the difference between the present value of cash inflow and the present value of cash outflow. In most cases the present value of cash outflow is considered as the initial cost or the initial cash outlay.  This means that net present value is used to determine the current total value of the future streams of the payment. The based on the net present value is consistent with the shareholder’s wealth maximizing goal of the firm.

The technique will involve the need of estimating the cash flows for each of the period and determining the correct discount rate. In most cases the cost of capital is used as the discounting rate.  During the estimation of the cash flow, it has been assuming that the revenues and costs incurred in the first year will not change for the next five years of investment. The number of mothers and babies per month will not change and remains the same for the five years. Based on these assumptions the following cash flow statements were made to forecast the next five-year performance and evaluating the project based on the appraisal techniques.

PROPOSAL	Year	1	2	3	4	5
Budget	1,500,000	2,700,000	2,700,000	2,700,000	2,700,000	2,700,000
10 fully equipped maternity theatres and labour rooms	-1,500,000
Private care		162,000	162,000	162,000	162,000	162,000
Private rooms with en suite and bed		280,000	280,000	280,000	280,000	280,000
Antenatal care	3,600
Initial blood and other tests: £60	£60	-216,000	-216,000	-216,000	-216,000	-216,000
Lateral flow antigen testing: £10	£10	-36,000	-36,000	-36,000	-36,000	-36,000
Ultrasound scans: £30	£30	-108,000	-108,000	-108,000	-108,000	-108,000
Genetic testing: £65	£65	-234,000	-234,000	-234,000	-234,000	-234,000
Antenatal screening: £45	£45	-162,000	-162,000	-162,000	-162,000	-162,000
Antenatal classes: £25	£25	-90,000	-90,000	-90,000	-90,000	-90,000
Birth care	3,000
Normal delivery: £150	2,100	-315,000	-315,000	-315,000	-315,000	-315,000
Planned and emergency caesarean sections: £220	600	-132,000	-132,000	-132,000	-132,000	-132,000
Birth pools: £185	240	-44,400	-44,400	-44,400	-44,400	-44,400
Home birth: £220	60	-13,200	-13,200	-13,200	-13,200	-13,200
On-site neonatal intensive care unit: £130	60	-93,600	-93,600	-93,600	-93,600	-93,600
Postnatal care	3,480
Breastfeeding support: £60	£60	-208,800	-208,800	-208,800	-208,800	-208,800
Postnatal physiotherapy: £95	£95	-330,600	-330,600	-330,600	-330,600	-330,600
Staff salaries
Maternity consultants: £280,000		-280,000	-280,000	-280,000	-280,000	-280,000
Maternity midwives: £260,000		-260,000	-260,000	-260,000	-260,000	-260,000
Maternity management: £350,000		-350,000	-350,000	-350,000	-350,000	-350,000
Sonographer: £150,000		-150,000	-150,000	-150,000	-150,000	-150,000
Clinical psychologist: £52,000		-52,000	-52,000	-52,000	-52,000	-52,000
Maternity support workers: £220,000		-220,000	-220,000	-220,000	-220,000	-220,000
Ward clerks and administrators: £160,000		-160,000	-160,000	-160,000	-160,000	-160,000
Medical supplies		-105,000	-105,000	-105,000	-105,000	-105,000
Overtime		-76,000	-76,000	-76,000	-76,000	-76,000
Other ongoing costs		-65,000	-65,000	-65,000	-65,000	-65,000
Net cash flows	0	-559,600	-559,600	-559,600	-559,600	-559,600

NHS trust should invest in the project when the net present value is positive. This means that the firm should accept the project because it will help the shareholders to increase their wealth. The net present value of the project will be computed from the excel using the following formula;

Net present value (NPV) = Present value of cash inflow – present value of cash outflow

Computation of net present value

Year	net cash flow	Discount factor	Present value
1	-559,600	0.9259	-518,148
2	-559,600	0.8573	-479,767
3	-559,600	0.7938	-444,229
4	-559,600	0.7350	-411,323
5	-559,600	0.6806	-380,854
		NPV	-2,234,321

At the discounting rate of 8%, NHS trust is making a negative net present value of -2234321. This means that the trust should not accept the proposed investment.

Net present value is useful because it incorporates the time value of money. This means that it will account for the risk and the uncertainty of the future cash flow.

By the use of this method the analyst will be in a position to know whether the project is delivering the value. The use of NPV will help the decision maker to determine the profitability of the project and they will invest in the project when it has a positive net present value.

The discounting rate used in the method considers the company’s cost of capital. This means that by the use of the discounting rate the firm is able to incorporate the risks of financing the business from the debt and equity capital.

The main disadvantage of this method is that it is hard to estimate the cash flows and hence the assumptions made when preparing the cash flow may lead to inaccurate data. The accuracy will depend on the quality of the inputs.

The method cannot be used to compare projects of different sizes. The method assumes that a large project that has a large net present value is better than a project that has small net present value. This assumption will make the decision maker to make the wrong decision.

In NPV method, the discounting rate is assumed to be constant at 8% and will remain for all the period of investment. The assumption is wrong because the cost of capital or the discounting rate will vary during the investment period.

IRR is the rate that will equate the present value of cash inflows to present value of cash outflow. According to Arshad (2018), the internal rate of return will make the NPV to be equal to zero. The decision maker will accept the project when the internal rate of return is greater than the cost of capital of the project. The internal rate of return can be computed using the goal seek tool in the Microsoft Excel program. The extension project of NHS trust is does not have the Internal rate of return of the project. This is because all the cash flows for the five years are negative.

Advantages of internal rate of return

• The method is useful because it considers the time value of money.
• The method also considers all the cash flow of the project during the investment period.
• The method offers the method that the projects can be ranked based on the profitability.

Disadvantages of internal rate of return

• Internal rate of return does not give the complete picture of the project.
• The method will ignore the size and the scope of the project.
• The method assumes that the cash flow that have been generated cannot be reinvested and it does not keep up with multiple cash flows.

The method helps to determine the duration of the project will take to recover the initial costs of the project. The method is mostly used when the projects are risky and decision maker will choose the project that has a short payback period. The main advantage of payback period is that it is to compute and understand. The disadvantage of the method is that it does not consider the time value of money. This project does not have a payback period because all the cash flow are negative and hence, NHS trust should not invest in the extension of the maternity unit.

The investment proposal has negative cash flow. The revision of the proposal would involve the reduction of the expenses or adding the machines. When the firm invests in additional assets, the firm will increase the initial cost. NHS trust is expected to reduce the costs and increase the revenues so as to make the cash flow to be positive. However, based on the market rate the hospital will not be in a position to increase the revenue or reduce the operation cost of the midwife maternity unit. Reduction of the current costs will lead the firm to be inefficient resulting to additional death and negligence claims. Based on this information, it is advisable the firm should stick to the original proposal.

Budgeting is a part of the project management that ensures that the total funds of completing the project are determined and allocated to the specific activities of the project. It is the role of the project manager to prepare the budget with the consultation to the project team. The project budgeting will involve the estimation of the costs in the upcoming project. The budgeting will help in determining the uncertainties that would occur during the project implementation. However, the budgeting process is faced by several challenges which include understanding and correctly estimating the individual costs for all the project activities. NHS trust requires to make the budgets which will help the firm to complete the project and know the sources of the capital of the firm.

Project management budgeting is a tiresome activity and hence NHS trust requires to use several methods to determine the appropriate budget for the project. Some of the types of budget which the firm can use to determine the appropriate budget include;

Analogous estimation

In this approach, the firm estimates the cost of the project through analyzing the costs of a completed similar project with the scope to the current one. The firm should make the adjustments so as to incorporate the scope and the period of the project.

Top-down budget

In this type of budgeting, the analyst will determine the project cost by calculating the individual costs of each of the required process. After that each part of the project is analyzed with the exact costs calculated and then compared to the initial estimate. This method will help the project manager to know whether they are efficient in cost management. The top-down budget will be used when the managers want the project costs to fit within the total allocated budget.

Bottom-up budget

In this budget, the manager will directly determine the project budget through the assistance of the project management team. It means that the decision of cost allocation is participatory.  The project team will give their views and their decision is very important in allocating the costs. The accuracy of the budget is usually proportional to the accuracy of the information and the expert’s advice received during the budgeting period.

These are among the best methods NHS trust can use when preparing the budgets. Based on this information, it is advisable for the firm to use the bottom-up budget process. The approach will make the project team to feel to be part of the project planning and they will participate in full making them to be efficient.

Sources of finance

The project requires the use of the finances and the trust has to acquire these sources from different sources. The source of the finance depends on the cost of capital and the solvency level of the firm. The sources of finance can be classified as the equity capital or the debt capital.  The debt capital includes the bank loans and the debentures. It has an advantage to the firm to finance the firm’s project through the debt capital (Lynn and Rosati 2021). One of the advantages of debt capital is that the interest charged on the firm is a tax allowable deduction. The second advantage is that the control of the firm is not diluted. The debt capital will help the firm to build its business credit score and it will be accessible to the business of any size.

According to Gupta and Singh (2018), for the firm to acquire the debt capital it needs to have good credit ratings and therefore, the firm is required to meet different qualification requirements. Some of the firms may not meet these requirements and hence it will hinder the firm from acquiring this form of financing.

The second disadvantage is that the firm has to have high discipline on finance management. The financial discipline is the main concept which will help the firm to make the repayment of the debts on time. When the business is overly dependent on the debt, it would result to the financial distress or solvency to the firm.

Equity capital

The equity capital is made up of the owner’s contribution to the business. The trust can finance the project through adding more capital to the business. The debt capital is a long-term source of capital. The payment of dividends is not compulsory and therefore it will not affect the liquidity position of the company.

The report of King’s Fund presents the conclusions and recommendations that affects the safety of the childbirth and childcare. From the report several issues affecting the safety in maternity have arisen. Some of the issues include;

The maternity team issues

The services of maternity should be provided by the teams and the groups of workers. The maternity services should not be provided by the individuals. The services will be effective when provided by the team and hence this increases the safety of the patients. The report show that the poor teamwork has caused decrease in efficiency resulting to safety jeopardize. Most maternity workers are facing recurrent difficulties during the teamwork.

Safety of the staff issues

The provision of the maternity teams will require adequate number of the staffs who have the right skills. The firm should ensure that there is effective deployment of the qualified personnel who will motivate the other employees.

Training for safety issues

From the report, there is a great issue on the training of the workers on the safety measures. Most of the organizations providing the health care services are not providing enough training to their workers. The services provided by the team can only be safe when the employees have been trained to provide safe services. The staff who are trained on maintaining safety will have the confidence in providing the services.

Role of the trust board issues

The report shows that there is low priority of maternity. The report indicates that most of the contributors complained of low priority of the trust boards. The other thing which is evident in this issue is that the health care provisions have poor focus on the safety. The possibility of this problem in the board is because there are very few health workers who are represented in the board and hence their safety measures cannot be effectively implemented.

Possible solution to the issue

Some of the solution to the problems of the role of the trust board include communicating the priority of the staff and patients in the board and also providing the data on the safety to the public. This will make the firm to be transparent.

The board should have a good governance structure which will ensure the safety of staff and the patients. Good governance strengthens the safety of the committees and the whole maternity service system.  

The other solution to the problem is ensuring that there is ethics in the maternity services. The health care providers should be ethical when providing for their services. When the staff and the board are professionally ethical, they will provide safety to the newborn child and the pregnant mothers.

Conclusion

The project management is a form of long-term investment and hence they are should be considered as the capital budgeting decision. The firm should use the appraisal techniques that will consider all the cash flow of the project. NHS trust should not invest in the new maternity project because it has a negative net present value. The firm can finance the project through the use of the debt capital or the equity capital. The financing decision of the firm depends on the cost of the capital and the capital structure of NHS trust. If the project was viable, the firm should finance it through the debt capital.

References

Arshad, A., 2018. Net present value is better than internal rate of return. Interdisciplinary journal of contemporary research in business, 4(8), pp.211-219.

Avellaneda Hortúa, M., 2019. The origin of present value as a capital budgeting decision criteria: A journey to Pisa in the middle ages.

Bora, B., 2019. Comparison between net present value and internal rate of return. International Journal of Research in Finance and Marketing, 5(12), pp.61-71.

Gaspars-Wieloch, H., 2019. Project net present value estimation under uncertainty. Central European Journal of Operations Research, 27(1), pp.179-197.

Gupta, M. and Singh, S., 2018. Sources of finance for hospitalized treatment in India: Evidence for policy. Indian Journal of Public Health, 62(4), p.308.

Juhász, L., 2017. Net present value versus internal rate of return. Economics & Sociology, 4(1), pp.46-53.

Kumar, N., Capital Budgeting Decision: Financial Management. Journal homepage: www. ijrpr. com ISSN, 2582, p.7421.

Lynn, T. and Rosati, P., 2021. New sources of entrepreneurial finance. Digital Entrepreneurship, p.209.

Mubashar, A. and Tariq, Y.B., 2019. Capital budgeting decision-making practices: evidence from Pakistan. Journal of Advances in Management Research.